The current capitation formula used to pay health maintenance organization (HMOs) for the health care services they provide to elderly Medicare beneficiaries bases payment on the enrollee age, sex, institutional status (living in the community or not) and eligibility for Medicaid. Currently, the rate paid to the HMO is 95% of the average annual per capital cost (AAPCC) in a geographic area. The formula is flawed because it does not adjust payment based on health status. This study will examine if self- reported health status measures can be used in a payment formula to reflect the health risk of enrolling a Medicare beneficiary under a capitation contract and, thus, improve the efficiency and effectiveness of the payment formula. Variables will be selected from validated health status questionnaires administered from August 1985-June 1986 to a sample of 2688 Medicare beneficiaries enrolled in a large prepaid group practice HMO. All health care utilization provided by or paid for by the HMO during a twelve month period following completion of the questionnaire will be used to estimate and test the model. this study splits the sample into two randomly assigned groups. The first, the estimation group, will be used to develop a prediction model of annual per capita health care utilization, and the second group, the test group, will measure how well the actual health care utilization of the test group fits the estimation model. Variables found statistically significant in the tested model will then be discussed for possible use in developing a new federal risk-adjusted Medicare capitation formula. This research will: develop and test a model which predicts annual health care utilization for individual aged Medicare beneficiaries enrolled in an HMO, based on self-reported health status and demographic characteristics collected approximately six months prior to monitoring utilization; derive a model of the components of health risk to guide selection of predictors of future costliness i.e. risk factors; specify the conceptual criteria and operational tests for evaluating the performance of alternative prediction models; examine the tradeoffs between multi-item health status instruments and simpler health status assessments in terms of their predictive power, reliability and cost; and recommend capitation payment reforms for Medicare beneficiaries by including risk factors which improve incentives for efficiency among HMOs.